Mobile TeleSystems PJSC (MBT) 2007 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Second Quarter 2007 Financial and Operating Results Conference Call. At this time, all lines are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will be given at that time. (OPERATOR INSTRUCTIONS)

As a reminder, this conference is being recorded today, Tuesday, September 4, 2007.

I would now like to turn the conference to the host, Andrei Terebenin with MTS. Please go ahead.

Hello, ladies and gentlemen, and welcome to MTS conference call to discuss the Company's second quarter 2007 financial and operating results. Before beginning our discussion, I would like to remind everyone that except for historical information, comments made during this call may constitute forward-looking statements which may involve certain risks. These statements may relate to one of the following issues; the strategic development of MTS business activities both in Russia and abroad, revenue and/or subscriber growth, syndicated loan facilities and their usage, legal actions or proceedings directed at the Company or its representatives, regulatory changes and the impact of the Company operations, the markets in which we operate, financial indicators such as operating income before depreciation and amortization, average revenue per user, cash flow projections and/or revenue -- return on invested capital, technical methods as they pertain to our mobile communication network including equipment, licensing for network technologies, and capital expenditures and operating expenses.

Important factors could cause actual results to differ materially from those contained in our projections or forward-looking statements. These statements may include Company press releases, earnings presentations, MTS Annual Report and Form 20-F, as well as other public filings made by the Company with the United States Securities and Exchange Commission, all of which are available on the Company Web site, www1.mtsgsm.com, or that of the United States Securities and Exchange Commission.

MTS disavows any obligations to update any previously made forward-looking statements, uttered on this conference call, or make any adjustments to previously made statements to reflect changes in risks. Copies of the presentation and materials used in references to this conference call are available on our Company Web site.

Participating on the call today are Leonid Melamed, President and Chief Executive Officer; Vsevolod Rozanov, Chief Financial Officer; Mikhail Shamolin, Head of Business Unit, Russia; Pavel Pavlovsky, Head of Business Unit, MTS Ukraine.

Now, I'll give the floor to Mr. Leonid Melamed.

Thank you, Andrei. Ladies and gentlemen, thank you for joining our 2007 second quarter conference call, an occasion to mark another quarter of strong growth in all of our markets of operation. For the period, we witnessed group revenue grew to $1.969 billion, a 32% gain year-over-year, while OIBDA grew over the same period by 39%.

Our Russian operations constitute the greatest driver to our growth, as revenues increased 37% year-on-year to $1.481 billion, while OIBDA in Russia grew at the rate of 50% over the same period.

Most intriguing, though, is what is happening in Russia. In contrast to other markets, growth is coming at the time when we are reaching effectively full penetration in our home market. Virtually, all developed mobile markets see a significant slowing of growth as penetration level reached 70% to 90%.

In Russia, on the contrary, we have seen an acceleration of growth. Revenues for the first half of the year were up 39% from last year, and penetration levels reached 110%. Many issues about the Russian market factored into this development, such as the favorable macroeconomic climate, the market's regional dynamics, and the positive regulatory environment. However, it's really usage that is the driving power. Total growth in usage reached 13% this year, whereas in the same period last year, we only saw 8% [drive].

At the same time, we also -- we have also maintained our APPM level. This is strong evidence of our ability to generate more revenues from our networks at prices satisfying to the end consumer. Overall, spending in Russia on a per capita basis [lags] other markets, both developed and emerging around the world. The percentage of GDP Russian mobile spending is roughly 1.5%, which is comparable to Germany, France, U.K., stable, developed markets that show little growth of dynamism.

On the other hand, emerging markets like China, South Africa or even in Eastern Europe, ultimately show while they spend that 2% or even 3% of nominal GDP. Disparity is a clear sign that an opportunity exists to grow this market. We discussed on this call previously raising this share or capturing the wallet is one of the primary factors that led us to adopt revenue stimulation as a key cornerstone of our Company strategy and has led to significant growth in our Russian operations.

In Ukraine, in spite of the increased competition in the market, our operations turned in 12% quarter-on-quarter growth, has become in the competitive pricing environment(inaudible) in Q2. As we discussed in our last call, we initiated (inaudible) at the end of Q2 in anticipation of our rebranding, which we launched in July after the close of the reporting period. That was too early to disclose any indicators, initial responses to the introduction of the MTS brand has been overwhelmingly positive. We anticipate a positive impact looking ahead.

At the same time, we continue to roll out our networks and maintain our market leadership in both Uzbekistan and Turkmenistan. In Uzbekistan, revenue doubled for the first six months year-on-year to $106 million, driven largely by a 14% increase in our subscriber base, as we maintained our market share of 56%. Penetration totaled 13% at the end of the period. With a compelling brand and a strong market position, we feel confident in our ability to manage depending high growth phase of the market's development and entrance into the mass market segment.

Turkmenistan's penetration remains low in the single digit range, due to the limited network rollout, but the market share is stable at 83%. Local input regulations restrict our ability to develop our networks, though we remain committed to serving this market.

Now, I pass the word to Vsevolod to elaborate more on our results.

Yes, thank you, Leonid.

The rise in group revenue has been complemented by substantial gains in group profitability. OIBDA grew even faster than the revenues. At the group level, OIBDA grew 45% for the first half of 2007, versus 33% growth in revenues.

In Russia, the difference was even more pronounced. The revenues increased 39% for the first half of the year. OIBDA improved 53%. This double digit revenue growth rate at this stage of the market is unusual, but the OIBDA growth is even less common in the maturing markets like Russia.

For the fourth quarter in a row, MTS delivered OIBDA margin in excess of (inaudible - technical difficulties). Our efforts over the past year to improve our bottom line are clearly evident in the results for this quarter. Net income in the Q2 improved 72% year-on-year. It has led to 100% improvement versus the first half of 2006.

Group financial management, more stable currency environment in Russia for the period, lower interest payments all are contributing to the bottom line improvement, with net income margin exceeding 25%. But higher than our developed market peers, and in fact, 5 percentage points higher than the aggregate average net income margin for our emerging market peers as well.

A mention on the balance sheet items for the first half of the year, our free cash flow totaled $825 million. We increased our cash position in anticipation of dividend payout beginning in early September, in addition to anticipate the reduced spending. Our net debt to OIBDA ratio fell to 0.5, as our total amount of debt is decreasing while OIBDA increases.

As we do have outstanding [dollars] in [Eurobonds] maturing in January 2008, we will examine various ways of refinancing, including potential issuance of ruble bonds later this year and in on market conditions.

And with that, I would like to pass the word to Leonid.

Thanks, Vsevolod. This past summer, we convened a series of meetings involving senior and middle level management from throughout the group in each of our markets of operation. These strategic sessions enabled us to marshal the full resources of our Company and chart our future in what is an demographically, economically, and technologically changing market. From the many positive ideas and initiatives generated in this session, we have amended our key corporate strategies to reflect our changing markets and meet the challenges that lie ahead.

We will begin with the core values of MTS. Number one, delivering always more for our customers. Two, striving to be the leading communications brand in the CIS. And three, creating exceptional shareholder value. To this end, 3+2 constitutes the core element enacting on this value.

Our first priority is to capture the full growth potential in our core markets. As I mentioned before, driving revenue stimulation is our focus, but we also must complement our attractive product with comparable service. Likewise providing a unique customer experience will differentiate us from our -- from other operators in our markets, something increasingly important and as our market share -- markets mature.

Our next priority is value creation in developing markets. With a market portfolio ranging from maturing to single-digit penetration, we have a unique opportunity to leverage our institutional experience and drive growth throughout our home base in CIS. At the same time, we are keen on enlarging our footprint in CIS, so as to gain better scale effort throughout the organization.

Our third priority is the development of wireless broadband. We have discussed on this call previously a combination of factors, including the proliferation of devices, equipment prices, [deep] broadband substitution makes our 3G network rollout more attractive than other markets [that we are in]. As our markets mature, that revenue becomes increasingly important to sustain growth, and capturing this growth is key to our long-term future.

Growth can come at any cost. This is why organizational efficiency has to be part of our outlook. The group is constantly focused on improving processes and efficiencies throughout our business. As scale is critical to our future development, floating synergies within our original market becomes more important in ensuring that we are expecting the greatest amount of value from our operation.

And if we are to expect that our customers will embrace the latest, most innovative mobile products and services, we need to equally embrace developing technologies, [floating] the latest technologies that have become a priority for the group.

Last, development of the overall group is the message by which we add greater value to our business operation, institutionalizing the experience we have gained in our markets and ensuring skill transfer throughout the group is critical to not only maximizing our business performance, but also in building up our overall capabilities, and providing a work environment to attract and retain best in class employees.

In sum, 3+2 is an evolution of the 3+1 strategies that had been [approved] last year. From that time, our business has changed, our markets have changed, and the Company has changed also. New competitive environments, new regulatory environment and new technologies shape and reshape our business. No matter what result our goals have and we will remain the same, providing more for our customers, more for our shareholders, and more for employees.

Thank you for your time and I am happy to open the call for questions.

Operator, we will take questions now.

(OPERATOR INSTRUCTIONS) And our first question comes from the line of Alex Kuznetsov. Please go ahead.

Good afternoon. Let me congratulate on the strong ARPU expansion in Ukraine. Could you let me know of your expected -- if the trend is expected to continue in the second half of 2007? Could you probably elaborate on the major reasons behind the Ukrainian ARPU expansion, apart from the traditional seasonality? And have you seen significant improvement in the competitive landscape in the second quarter, and do you expect the improvement to continue throughout the year?

And my second question is regarding the announcement you made earlier today. There was a comment earlier that Mobile TeleSystems is going to increase leverage by borrowing $1 billion, which is quite an interesting development, given increased cost of debt and growing cash flow generation we have seen last quarter. Could you comment how you are going to use the debt, please?

Thank you for your questions. Good afternoon. Let me pass it to Pavel Pavlovsky, the Head of Business Unit, Ukraine, to comment on ARPU developments there.

Yes, thanks, Leonid. Good evening, everyone. It's evening in Moscow.

Talking about ARPU dynamics in Ukraine in Q2, yes indeed, we saw some noticeable growth in ARPU, which resulted from a higher usage. Indeed impacted by the seasonality, a high season, but also we are from Q2 and even more in Q3 have been producing a main brand, which stimulate the usage and we introduced a regressive tariff stimulating the usage pattern, and we also see the competitive situation is cooling down a little bit and even more in Q3 again after the introduction of a new brand and our new tariff, with so little response from the competitors, which gives us a good sign. So, we do hope that this trend will continue, although we shouldn't be over-optimistic.

Thank you and let me pass it to Vsevolod Rozanov.

Thank you, Pavel. I will take the second question on the potential debt increase. The -- as it was previously announced, we are likely to register the ruble bond issuance with the Federal Service for Financial Markets later this year for the sum of up to RUB30 billion. This is -- this sum is by no means the exact number, and the exact number will depend on the general corporate needs. As we -- and another reason for attracting the position in the ruble bonds is the refinancing of the Eurobonds, which is due to mature in the January 2008. At this stage, we do not -- and I would like to reemphasize it, we are not aiming to attract $1 billion. We are registering the prospectus for the sum if there is a general corporate need over the course of the next year. Thank you.

And the next question comes from Herve Drouet. Please go ahead.

Good afternoon, this is Herve Drouet from HSBC. Two questions. First one, on CapEx. Your CapEx looks relatively low, as percentage of revenues, especially compared with previous year. On the other side, we see usage increasing very fast on your network.

I was wondering, do you experience any congestions of traffic in some cities or in some countries, and how do you see CapEx evolving looking forward especially in the second half, and do you have any guidance or any change in guidance regarding CapEx for the end of the year?

The second question is regarding 3G. I was wondering if you have any detailed plan or a bit more detailed plan of your rollout plan for third generations? Do you have any date or quarter in mind in terms of commercially launching operations with 3G in Russia? Thank you.

Thank you for the question. Regarding the CapEx numbers for the year 2007, our guidance that we have given at the beginning of this year is due to that we will spend about $2 billion, including 3G rollout plan, remains unchanged. And we observed the consequences of our official procurement policy we have introduced this year. And as long as our CapEx numbers are reflected not in accruals but in cash, we don't see the full reflection of our expenditures, let's say, in the numbers of the Q1 and Q2.

But, in Q3 and Q4, we believe that they will be fully reflected in accordance with the agreement signed with the vendors and construction companies. So, we are full on the way to adjust our network to the increasing requirements of our customer base.

On another hand, I can state that we don't see now any specific decrease of quality on the network in the majority of the regions of our operations, and we thoroughly measure them on our daily, weekly and monthly basis, and all of the parameters are in line with the standards applied for MTS group, due to the serious capacity that our networks still have due to the previous development, and due to the reasonable planning of the network development that's been applied in the Company through the years and for the year 2007 in particular.

For 3G rollout, we understand that -- so we proceed with the development right now, especially in these -- there is a long list of activities that we will have to undertake before the commercial launch, including the planning of the network, including the construction activities and deployment of the equipment, including preparation of the marketing and advertisement size and everything -- all special, let's say, functional activities due to such kind of a plan.

All of that is under development right now in MTS group. As you know, we have already chosen the vendor for 3G equipment for Moscow region, and through the last couple of days, they made the first successful test of the initial parts of the network deployed in the Moscow region. And very soon, I believe we will accomplish the tender to choose the vendors for the other parts of the Russian Federation to deploy our network in the end of this year and in the year 2008.

We are -- with the frequency clearance, we understand that we will, in the majority of regions where we plan our operations in the year 2008, we will be able to operate and launch the commercial usage of the 3G network in the first half of the next year. In Moscow -- though in Moscow, that is of course of primary interest to us. The situation is still less clear than in the other territories, and -- but we also believe that due to special effects of the government and from another hand, of all operators here, we will be able to also start commercial usage in the first half of the next year.

So, in general terms, we can state that our deployment plans are developing in accordance to our initial plans, and we don't anticipate big delays on starting the commercial use of the 3G network.

Thank you very much.

The next question comes from the line of [Yakov Lashelin]. Please go ahead.

Good afternoon, everyone. There was a headline today that MTS was thinking of buying back approximately 10% of its ADRs. Could you please comment on that, and if this is something that you do consider, how do you see your funding needs changing with this respect? Thank you.

Thank you for the question. The Board of Directors of MTS actually just finished an hour ago, and one of the decisions of the Board of Directors was to proceed with the ADR buyback program exactly in the way it has been approved last year, so for another year in a row. So, there will be no changes in this program in the next coming 12 months.

And so, you see -- your Company been able to utilize its own cash reserves and not tap in the markets for additional borrowings?

We understand that we have now a lot of specific tasks in developing of our Company to use the free cash flow that we have, and in order to finance our organic growth and potential inorganic, I would say, solutions and development. But, we also consider, let's say, quite seriously the opportunity to buy back our stocks if the price would be reasonable, exactly in the way we approached this task through the last 12 months.

Thank you.

And our next question comes from [Eric Muller]. Please go ahead.

Hi, gentlemen. Congratulations on strong 2Q results. I have a question for you on the local shareholder, and the locals carry the same economic and voting rights, yet they trade at 18% discount to the ADR. Now, I am willing to acknowledge that the ADR is -- the program is full and there's probably not any fungibility. But, I just wanted to ask, what is the Company undertaking right now to hopefully narrow that discount to the ADR?

Thank you. So, our activity in this area is concentrated on the presentation of the Company results. And from one hand, in the presentation of the investment opportunities that with the local stocks of MTS for the local investors. And this autumn, we plan to undertake [at the] end of our road show this strategy through the Company among the local investors, to attract more interest and increase the liquidity of our stocks in the local market. And that's actually the first step in this direction from our side and based on the results, we will see what else we should do to somehow change the situation that we understand is uncomfortable for the investors of the local [firm].

Okay, thank you very much.

And our next question comes from the line of Nadejda Golubeva. Please go ahead.

Good afternoon. Congratulations on strong results.

First of all, could you please comment on the decision regarding the strategy, why you bought, so as I understand now you are going to be restricted on the return on the projects you can undertake, so I am particularly interested in how much of the return are you going to sacrifice now if you see that certain strategically important, as you are [seeing] here, and the rate of the return on investment is considered at all, and whether there is still some floor level below which you want to undertake a project in any case. This is some sort of strategic question.

And my several specific questions I have, first of all, I wonder whether you could disclose interconnect revenue in Russia, and also, can you give us the advertising expenses in Russia in the second quarter and possible requirement on the increase of G&A as percentage of revenue compared to the first quarter? Thank you.

Thank you, and thank you for the complement with our -- for our results.

It's a very good question, and we really would like to be very clear here. Our 3+1 strategy showed our very strict, as we call this, monetaristic approach to the main initiatives and activities inside MTS group. And what is very important to state is that our 3+2 upgrade of the -- our 3+2 strategy is an upgrade of our 3+1 strategy, and we in no way would like to change, let's say, or alter any of the main statements that have been done by the Company in the 3+1 strategy.

So, we would like to apply a very thorough, diligent approach to all kinds of investments that we make in the future. And what is also important, we will stay very much devoted to show the financial results for our shareholders at the levels that had been announced a year ago.

So, our task to create a ROIC of 25% in the five-year perspective for our shareholders is still on the agenda.

But, let me attract your attention that our current ROIC is 43%, and it's also because we have applied very strict regulations on the investment projects that we have been undertaking.

Now, we -- what we say is that we are keeping on the way of very diligent starting or reaching a project and applying very strong -- strict, keep your eyes on each project, we are prepared for -- to consider the projects with the like a bit longer paybacks than before as still keeping ourselves able to provide very attractive paybacks higher than 25% in the five-year perspective to our investors.

We are sure we can do that, because from one hand, the market showed quite different, much more positive behavior than we anticipated it to act a year ago. And as long as we are [free], then we forecast 142% growth of revenues in the Russian Federation in the next coming five years in the mobile sector, we understand that we have room for, let's say, more, I would say, aggressive investments that would still give us excellent returns.

As an example, let's say, of this approach, I can, let's say, comment on the plan that we are going into investment in Uzbekistan, where we plan to develop the 3G network and we plan to start this development next year, where we are sure that the payback period would be a bit longer than it is usual for other our operations. But we, as long as our 3+2 strategy says that wireless broadband is the strategic goal for the Company, we believe -- and as long as we believe that this investment would really bring a lot of returns to our investors in a bit longer perspective than like we used to think before. We will most likely grow and invest into this project quite soon.

So, this is the example of how we in favor of our strategic target under very strict control on numbers and [DPIs] are prepared to, let's say, invest into the projects with, let's say, a different financial perspective that we have been ready to invest a year ago.

But, we are anyway absolutely sure that this trend will allow us to provide to the shareholders the returns in the long and -- in the short-term and long-term perspective that we have been orienting them without, let's say, previous statement.

Okay, thank you very much. And my other question?

Mikhail, please?

Yes, this is Mikhail Shamolin speaking. Hello.

Interconnect revenues in Russia were up to $170 million, which is 15% growth through the first quarter. And increase of G&A as a percentage of revenue, we had a very slight increase I think from 6.8% of revenue to sort of 7.2% of revenue, and that was mainly due to increased cost of advertising expenses, because we had more active advertising in the second quarter than we had in the first.

And should we expect less advertising in the third quarter, or should we expect approximately the same level of advertising as a percentage of revenue?

In terms of advertising spend, we expect pretty similar levels, but we are not -- we will not be giving a guidance now of what percentage of revenue that will be.

Okay. And a follow-up on interconnect revenues. In Russia, so your interconnect was $170 million, correct? And when I look at VimpelCom's interconnect revenue in Russia, I see $203 million. And so, given that you have roughly a similar size of subscriber base, I would assume that your interconnect should be equal. But still, your interconnect is 16% less compared to VimpelCom, so like the explanation I could give that your subscriber base is a bit, say, well, inflated, yes, sorry if you don't like this word. But, your ARPU should be a bit higher compared to VimpelCom, or could you give some possibly other explanation on why your interconnect revenues in Russia could be less compared to VimpelCom by a pretty sizable 16%?

We don't really comment on the competitor's activities. So, I wouldn't be explaining why VimpelCom's interconnect revenue is at the level that it is. I could only assume it relates to the traffic patterns and the particularities of the marketing programs, for instance. I know that in the market, there are certain price plans which stimulate incoming calls, interconnect calls, and where customers are being given a bonus for receiving incoming calls, and that may essentially affect the difference in the interconnect revenue.

Okay, okay, fair enough, thank you very much. And can you disclose the advertising expenses in Russia?

Pardon me?

Could you give us a number for advertising expenses in Russia?

Yes, I am not sure we are disclosing this information, if it can help.

Okay, thank you very much.

The next question comes from the line of [Will Nolmer]. Please go ahead.

Thanks. Just a few questions on usage in Russia, and I guess following on from the last question, really. Can you just confirm that the usage figure that you quoted in Russia includes both outgoing and incoming minutes?

Secondly, can you confirm whether you have established any new interconnect agreements in the second quarter, with either fixed or mobile operators? And thirdly, can you just -- can you just confirm or let us know what percentage of your Russian traffic is on that, and I guess how that trend has evolved over time? Thanks.

Usage in Russia includes all minutes.

Okay.

The interconnect agreements, we did not have any interconnect agreements in Q2. And as a percentage of traffic on the on-net it is around 60%, about 60%, Russia.

Okay. I mean, without the establishment of new interconnect agreements, could you maybe just outline what some of the products and services are that you have launched that have stimulated the usage in the quarter?

We have from -- we have multiple initiatives. First of all, we have products that are targeted for group usage. Those are two groups of products. One basic product, which you call -- product which we call [Rev], which stimulates usage within network of friends or relatives, and this is mainly for youth-oriented. And then we have a second line of service, which is called [We], and this is clearly a family tariff, where a family of five could talk again on-net within this tariff plan cheaply, and that's stimulated lot of traffic.

We also have so-called options, which we add onto our tariff plan, basically any tariff plan. This includes things like unlimited weekend calls for a fee, unlimited calls at night for a fee and other activities of that nature. In the second quarter, we have also launched a credit program for mass segment, which is something which we did not have before in the market. And that also stimulated usage, because it allowed to people to essentially, not limiting their conversations by being switched off while their balance is zero.

Okay, that's very helpful.

And then also, additional initiative is try and buy on the value added services.

Okay. I mean just as a quick follow-up, I guess looking at the sort of pricing and usage trends you are seeing now in Russia, you are seeing I guess relatively flat ruble pricing kind of quarter-over-quarter, but a big 13%, 18% increase in usage year-over-year. I mean, is there any reason to suppose that those trends won't carry through into the second half of this year? I mean, and certainly do you -- and certainly how do you think about those?

One of the basic explanations I could give you is presented on page 31 of our presentation -- I believe you should have it -- which is -- which is MoU figures on the prepaid and the postpaid segment, which is 510 minutes on the postpaid and 110 minutes on the prepaid.

And as you probably know, in Russia, the prepaid -- or the postpaid is not a classical -- in most cases, is not a classical credit postpaid. It's subscribers that have contracts, but essentially the -- most of them keep their balance above zero. So, they are effectively prepaid from that perspective. And the only difference between them in this classification is the level of ARPU and the level of income, which basically tells you that as the level of income is going to be increasing, the usage is going to be increasing as well. And therefore, that sort of gives you a range of where usage could go, and that's why we believe that Russian market does have quite a significant potential for growth.

Okay, thank you very much.

The next question comes from the line of Dalibor Vavruska. Please go ahead.

Hello, good evening. I have two questions regarding -- basically following up on the initiatives that you had in the second quarter that stimulated the usage. I am just wondering, VimpelCom talked about their initiatives, where basically they are giving some sort of free minutes after or very cheap, discounting minutes after certain number of minutes of call, and they explain the increase of usage pretty much based on -- or they said these initiatives helped.

And I am just wondering whether that was the case for MTS as well. And if that is the case, what is roughly the proportion of these free or heavily discounted minutes in your traffic as a result of these promotions?

And secondly, maybe this is not significant and I might be wrong, but I have heard that for the high-end customers with direct numbers, there were some additional charges introduced at some stage. I am wondering if that was in the second quarter, and if this was significant in any sense in terms of revenue for the Company. Thank you.

Okay. First on the usage. We have two basic tariff lines which comprise the majority of our sales, and both of those tariff lines are centered around usage. The basic tariff, which we launched last year, right after the rebranding, was the tariff plan called [First], and the essence of this tariff plan, the first two minutes, let's say at $0.10, and the third and other minutes are $0.05, for example. And therefore, the longer you talk, the less you're paying. That's the usage by itself.

And the second line of tariffs is called Freely or Svobodny in Russian, and that tariff stimulates a lot of short calls during the day, because we have a usage pattern in which people, especially in the mass segment, tend to call five, 10, 20 times a day, but have very short conversations, like less than a minute. And essentially, this tariff plan stimulates people with lower price per minute up to four minutes of total use during the day.

So, basically, they make four calls and the fifth call already is much cheaper, and that stimulates usage by itself, because people do buy those particular tariff plans to talk more and they get a value for having longer conversations or more calls. And it also works for us, because if you look at the APPM figures, they have not really changed. So basically our APPM is stable. We're not cutting down on prices heavily, and we're therefore not reducing our revenues while creating value for clients.

As far as the high-end customers are concerned, we had one sort of step-change last year with the introduction of the CVP, when we introduced certain charges on the certain fee on the direct numbers, and that fee was only to compensate the fact that after CVP has been introduced, calls from fixed networks to direct numbers did not fall under the interconnection deals.

In other words, they would have been free for customers, if this fee wasn't introduced. And basically, the whole market has done something similar, and since then we have not really introduced any charges.

Okay, well, that's very clear. I mean, if I can ask maybe on the first question, just this one more detail, has there been any sort of unlimited or quasi-unlimited offers that MT has offered, that basically customers would pay after a certain number of minutes zero, or that they can prepay per month? Any sort of offers with unlimited nature?

Yes, of course we have, and we have had those tariffs for a number of years, when actually you pay -- I think in Moscow, it's $130 and you have unlimited local traffic.

But no promotion or nothing new on that in the second quarter.

No, not really.

Thank you very much.

We'll introduced a couple of tariff plans for white collars, which also have some benefits on the inter-city connections, like inside MTS network, our customers can make inter-city calls for the price of a local call, which also stimulates traffic.

Okay, thank you.

The next question comes from Konstantin Chernyshev.

Please go ahead.

Good evening. So, a question regarding slide number 31. According to the slide, value-added services as a percentage of ARPU declined from 17% in Q2 '06 to 11% in Q2 '07. Can you please comment on that? And one additional question, what is the share of SMS in value-added services?

Okay, first of all, on the percentage of VAS ARPU decline. The primary reason is because growth in usage happens mostly in the mass segment. These are the people who have owned mobile phones for a year or so, and they are sort of getting used to the device. It is becoming a part of their life, and they start using more and more minutes. And therefore, voice usage grows.

And, of course, the VAS usage is lagging behind, because the level of sophistication of those customers sort of increases gradually, and we expect that we will see the value-added services as a percentage of this revenue catching up in the mid-term.

As far as the SMS are concerned, it comprises approximately 55% of the total value-added service revenue.

Okay, thank you.

The next question comes from Olga Bystrova.

Please go ahead.

Good evening, Olga Bystrova from Credit Suisse. Congratulations on strong results. I have a few questions. One is a follow-up on the ARPU and ARPU drivers dynamics in Russia. Basically, given that you've introduced a few promotions and new tariff plans in July/August, how do you think -- basically, how do you think elasticity could look like in the third quarter because of that?

The second question is regarding the extension of a buyback program. In general, you haven't really executed on that program heavily in the past 12 months. Why do you think you will be interested in doing it now and completing it maybe over the next 12 months, and what is, let's say, your preference for dividends versus repurchases?

And the final question is on Uzbekistan, because on Uzbekistan I think the situation was a little bit less in my view successful, but I could be wrong. Could you explain sort of what is your strategy now, because pricing has been going down quite significantly for you in that country?

Thank you very much.

Yes, on the ARPU, we have essentially introduced three programs in July and August. The first one was a triple bonus program, which effectively gives our customers a bonus every two months for the period of six months for staying within the MTS network.

Therefore, in the third quarter, we will not see any negative effects of this program, and overall we believe this program is quite positive, because it helps increase loyalty and retain customers and reduce churn.

The second program was promoting inter-city calls, inter-city calls within the MTS network at the price of a local call, and this is essentially giving our customers a true alternative to fixed, because the pricing there is quite similar. Therefore, we don't expect any sort of effect on APPM, and maybe a positive effect on ARPU, because we've had this pricing in the past and now we are just promoting it.

And the third initiative was a special tariff for schoolchildren, school kids, launched before the 1st of September, and this is in Russia a very good date to launch something like this. And, again, APPM on this tariff plan is at the average level of APPM, and we hope it's going to be successful.

So, in other words, we have not launched any initiatives which would lead to an ARPU decrease. And as far as an ARPU increase, I don't think we're guiding at the third quarter today, but certainly we don't see reasons for why it would decrease.

Okay, and I think maybe just a quick follow-up. I think there was one tariff plan where you have RUB0.15 per minute after the third minute or something like that, if I'm not mistaken. Is that correct, and sort of what do you see on the tariff currently happening for usage and ARPU development?

Yes, this is a tariff plan which was called [Super First], and it hasn't been advertised heavily, and the sales on that tariff plan are fairly limited at this point. But we are planning to promote it further on.

This is a continuation of the First line of tariffs. It promotes a very attractive price point to our customers, but this tariff differs in its structure from region to region, and the difference is in the number of minutes after which it becomes RUB0.15. Like, in Moscow it's, I think, after four minutes, and in some of the regions where competition is high and therefore APPM is lower, it may be after the second minute, or even after the first minute. It depends on the local competitive landscape.

Okay, great, and the other two questions?

On buyback, we understand that in the set of priorities in our capital expenditures, buyback is one of them, but not the one, and I believe it's well communicated by us to the investment community. It's going to be like that in, as far as I understand, the next coming 12 months. We see different developments in the stock market, and at some stages it will be quite useful from commercial viewpoints to get an instrument to buy -- to allow us to buy back our stock and to have good returns on these operations in the midterm perspective.

We're not planning to cancel the stock, and the goals of those acquisitions are still the same as we declared before, is to use them in the future M&A deals or to use them in the management (inaudible) incentive programs.

But, from another hand, as long as this is the related question, we have to confirm that there have been no changes in our dividend policy, recently approved, and I believe it's important for the investors to be aware of it.

Regarding Uzbekistan, the situation there is quite interesting. So from one hand, you have significant increase of customers. We've passed the level of 2 million customers in Uzbekistan in Q2. The penetration level doesn't grow let's say very quick, but we believe soon it's going to become really a mass market. I would say (inaudible - technical difficulties), and we will have to play an important role in this development.

What is also important is that we've really faced fantastic consumption growth in Uzbekistan. Our MOU there is growing from quarter-to-quarter, and it's now on the level of 549 minutes. And the ARPU decrease is relatively small, and actually on the year terms, and in Q2, our ARPU happened to be even higher than in Q1.

So we have -- and this result we achieved with very low APPM, so we have to be very accurate with the situation on pricing there. We have to catch up the trend of increasing usage, and let's say prepare ourselves with the full knowledge we have throughout the group to the significant increase in penetration level.

Okay, great. Thank you very much.

And the next question comes from the line of Stephen Pettyfer.

Please go ahead.

Thanks. Good afternoon, Stephen Pettyfer, Merrill Lynch. Just a few questions on the cost side of things, please. Firstly, in the past, you've provided a breakdown of your costs as a percentage of sales. I wonder if you could do that again for us this quarter, in Russia, specifically.

Secondly, in your presentation or on the slides, you mentioned for Ukraine that the margin benefited from lower advertising and marketing ahead of the rebranding, and I wonder if you could confirm to us that you're effectively saying there that you think the margin could come down in Q3?

In Turkmenistan, you also make a comment there about an additional licensing expense being the reason for the change in margin there. I wonder if you could comment on whether that's going to continue?

And then, on a separate matter, coming back to share buyback, given your fairly ambitious or large objectives there in terms of numbers of shares to buyback, can you foresee any time when you would change your thought about potentially canceling those shares? Thanks.

Thank you, Stephen. This is Vsevolod. I'll just start with the cost structure discussions. Speaking about the group, we had 8.2% of sales and marketing expenditures as a percent of revenue. And for G&A, it was 15.6% -- for G&A expenses, 15.6%.

There was a slight increase in sales and marketing expenses from the Q1, from 8%, and there was also increase of G&A expenses from the Q1, when the percentage of sales was 14.5%.

The key reason for that increase in the G&A expenses was actually this one-time charge in Turkmenistan, where we paid in tax arrears basically in the sum of approximately -- or just above $10 million, and we consider this to be a one-time effect.

Speaking about the developments in Russia, there was a slight increase in sales and marketing expenses, from 6.9% to 7.6% in the Q2, and that was the reason which we discussed actually during the Q1 call, when we said that the sales and marketing expenses was unusually lower, or due to the reason or the fact that we first changed from the dollar-denominated tariffs to ruble-denominated tariffs during that time and we didn't promote any new initiatives in that period.

Speaking about Ukraine, I would say that we do not expect significant change in the sales and marketing cost as a percentage of revenue, and basically we think that, as we discussed, the image costs were decreased and they are substituting now with the new rebranding costs. So might be a slight increase, but nothing exceptional is expected.

And the second question was on the --?

Turkmenistan.

On Turkmenistan, yes, I mentioned that it probably was a miscommunication. It's not relicensing, but it's tax charges, one-time tax charges in Turkmenistan that caused the significant decrease in OIBDA margin in the Q2.

Okay.

And speaking about share cancellation, we believe that at this stage, the key goals of the share buyback are remaining the same. If there is a change in the goals of the share buyback or in any parameters of the program, there definitely will be information about that.

Thanks. And I can I just come back to the Russian costs again? Can you tell us what G&A was as a percentage of sales in Russia?

It was 15.7% in the Q2 and 14.9% in the Q1.

Thank you.

And our next question comes from the line of [Alexander Baloflin].

Please go ahead.

Good evening. My question is a follow-up on your local ADR discount. Will you probably consider local share buyback to eliminate it? Thanks.

We have studied this issue thoroughly under the special request of the Board of Directors of the Company, and there have been of course some pros and cons on doing that. And the main reason why the Board of Directors did not support this idea was that we can really decrease the liquidity on the Russian market once we buy back our local stocks and, among all of the potential advantages, this was chosen to be the main factor not to go for this initiative.

So the answer is the Board of Directors don't support it, and in the next coming year we are not in a position to do it.

And on your ADR repurchasing program, according to your financials, you spent roughly $40 million for the repurchasing. Should we anticipate the acceleration of the repurchasing? Or it will depend on market situations or something like this?

Thank you. The situation, the technology of this buyback is that we are, in accordance to the American regulations, we issue instructions to our broker every quarter, and once we do that we take into consideration the current cash flow position of the Company, the market developments, our forecast of, let's say, those developments and our own understanding of what is a fair price for the stock of MTS.

So we have four times a year to make up our mind on this. Currently, through the previous year, our behavior was quite stable. There were no changes to our approach in this program, and we observe the current trends on the market quite attentively. And if there would be some changes, we will have to react in accordance. If the station would stay the way it was like a year before, we would I believe keep on the policy and buyback we've been promoting through the whole year.

Okay, thank you. And can I ask a third question on the Ukrainian pricing. Considering very tough competition in the Ukrainian markets in the past and very low current yield per minute, do you think it is possible to increase prices in the Ukraine, or it's completely impossible?

This is Pavel Pavlovsky. Obviously, we introduced a new plan to support this at the new price offering in July this year. We don't see, as I said, any, I would say, unreasonable response from our competitors, so that goes well. But at this time, I don't see any opportunity to increase prices, and I don't think it will be well perceived by the market.

I have to remind you that Ukraine is even a more price-sensitive and very price-oriented culture as a whole, even compared with Russia. But I have to stress that our strategy is to position us as a premium operator in Ukraine. Therefore, next year we believe we will be well-positioned, given all the investments we made this year into quality and service, et cetera, to be positioned at premium to the overall level in Ukraine. Thank you.

Thank you.

The next question comes from the line of [William Kirby].

Please go ahead.

Hello. I have three questions. Firstly, your sales expense was low in both Q1 and Q2, despite high advertising inflation. A previous caller brought up changes in the general and administrative line, so I just want to clarify what is in sales versus what is in general and administrative? And then, also, what will be driving the sales line in the future?

My second question is similar, on tax rates. They were lower in H1 '07 than in the same period in '06. Is this due to the ForEx gains, and what else will be driving this line?

Finally, on your gross margin, we had expected maybe that your gross margin would trend upwards -- sorry, would trend downwards because of rising interconnect. How have you managed to keep it where it is?

Thank you. This is Vsevolod, and first of all, I would kindly ask you to repeat the first question.

My question was on sales expense in Russia, the sales and marketing line. Despite high advertising inflation in Russia, this has remained low. How have you managed to achieve this, and what do you expect in the near future?

Well, we have it more or less in line with our forecast, to keep it below 10% of the revenues, and I think that going forward, this number is likely to remain the same. In spite of the price inflation, we make the sort of management decision on that in each particular country.

Speaking about the tax rate, you are definitely right. This is mainly ForEx development, which drives the tax rate, and this is exactly the case for the difference between the Q2 of this year and the Q3 of last year.

Speaking about the gross margin development, we've seen decrease of sales on the handsets and other accessories this quarter. That's basically led to improvement of our gross margin.

Okay, sure, and thank you for the information on taxes. Is there anything else that you foresee impacting your tax rate in future years, or is it mostly just due to fluctuations in foreign exchange?

Well, I don't see any other major factor which might be influencing the tax rate.

Okay, thank you.

I just wanted to add something to the marketing expenses. The inflation, the media inflation, is typically accounted during the negotiation for the year contracts, which typically happen sort of in the fall of the year before.

In other words, all the media inflation has been negotiated and put in the budget already in the fall of 2006, and the difference in the media cost between quarters is driven not by inflation but by the level of advertising activity, which is tied to the marketing plan and tied to seasonality. So it's purely related to how we structure our marketing activity.

Okay, so what can we expect for next year? We see rising advertising costs coming into the Russian market now. Does that mean they will feed through next year, or will you be reducing advertising spend?

Yes, we will not be giving guidance on this now. I can tell you that we will see further media inflation in Russia, for sure, with regards to TV and some other major advertising channels, but we are in the process of formulating exactly what our marketing plan is going to be, and therefore what advertising support is going to be needed as we speak.

Okay, thank you.

And the next question comes from the line of Andrei Bogdanov.

Please go ahead.

Yes, a few questions, if I may. The first one, a short one. With regards to Belorussia, are there any developments there with regards to your plans to increase your stake in the joint venture and consolidate the financials into your numbers?

The second question is more a kind of long-term question. Well, given the success of your business, the strong cash flow generation, you already have $750 million on your balance sheet in cash at the end of the first half. Going forward, it will be more than this, and obviously there is not many expensive projects you can be involved in. 3G is let's say $1 billion, and potentially a few acquisitions in CIS, but given your cash flow generation is not so big.

So the question is, going forward, what do you think you'll be doing with your cash, obviously if you won't have anything significant outside of former Soviet Union? Will you increase your dividend payments or whatever? What should be your plans with that regard?

And the really last question is you also mentioned today in conference call that wireless broadband is one of your strategic goals going forward. As you probably know, another Company in the Sistema Group, Sky Link, just last week said that they're going to five-fold raise the market share of revenues from 2% to 10% of the whole Russian mobile market, obviously capitalizing on the wireless broadband CDMA service they are offering.

So is there any kind of view on that from your side, and do you have any KPIs or let's say commitments from Sistema with regards to distribution of the market between you and Sky Link? I know you are different companies, but any insight on that will be helpful. Thank you.

Thank you very much for the question. On Belorussia, the situation for us is almost the same like it was before, so we have an open proposal for our partner, in case he would like to sell the assets, we are prepared to buy it. And the fact that recently they've sold the controlling -- the second-largest operator in Belorussia, VELCOM, gives us the sign that probably we will be able to negotiate our acquisition of the control in the company in a more effective way than we managed to do it for the time being.

About the usage of free cash flow, we don't have any special strategy on that for the time being. We understand that we have to finance our organic growth, including 2.5G developments in the countries of our presence, including 3G developments. We will finance the extensive growth, so like acquisitions, mostly we believe in the territory of the CIS, in mobile sector, in the next coming period of time, if it will be available for us.

So this is like the second course of investments from our side. We will invest into the improvement of quality or increase the quality of all major areas of our operations in accordance to the 3+2 strategy, where the quality-centric and [event]-centric approach is announced to be the main conceptual idea.

And on top of this, we have the dividend policy of the Company, approved by the Board of Directors in the Q2, actually, of this year, and we plan to implement it. And also have a buyback program. That's actually the set of directions of CapEx expenditures, and where the priorities are the fulfillment of our 3+2 strategy, and of course following the dividend policy told by the Board of Directors.

And regarding the wireless broadband, we are very optimistic toward the development of this market in CIS in general and in the Russian Federation in particular. And the preconditions for that are we have already discussed, with the low penetration of fixed-line Internet access, the favorable prices for the equipment, the growth of wealth and distributed income among the population, and the growing demand for broadband Internet access, plus increase of services and the services that people and organizations can extract by using the broadband access.

From that, we believe that only in Russia, the next coming five years, the mobile broadband would grow from almost, let's say, very small numbers that we have now, especially the majority of those numbers are driven by Sky Link and the, let's say, GPRS [niche] activities of the current operators to the number of $3.4 billion in 2012.

And we as a Company would like to play an important role in the distribution of this revenue pack, and we also hope that Sky Link will also be effective in gaining its market share. Of course, we don't receive any instructions from Sistema on the competitive behavior for MTS, and I believe it goes without saying. Thank you.

Thank you.

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We have a follow-up question from Alex Kuznetsov.

Please go ahead.

Good afternoon. I have a few follow-up questions. Just before, there were some comments regarding a potential acquisition of the second Armenian operator. Your competitor VimpelCom bought Armentel at the beginning of this year, and I believe it may have sense for you to enter the market. But could you probably comment on the financial parameters of the Armenian operator currently considered for an acquisition, please? Would you be in a position to comment on the EBITDA margin and ARPU?

Second question is regarding 3G deployment in Ukraine and Uzbekistan. Could you probably share with us your outlook on the license allocation and the licensing requirements in those countries? And, finally, could you let us know your target capital structure and the amount of bonds maturing at the beginning of next year? You pointed out previously that one of the reasons you have registered the bond issue is that you have to finance bonds maturing at the beginning of 2008.

Thank you very much.

Thank you, Alex. Well, the first question is quite an easy one. We definitely have interest in coming in the Armenian markets. We have interest in the acquisition of [Ka-Tel]. We are not in a position to comment anything about this company. We believe that the market is attractive, especially for MTS, due to the synergies we have in the group, and as long as it totally corresponds with the 3+2 strategy that we've announced today.

So if we will be successful to step in this market, we will give a full explanation on the details, and we will try to make you share with us the reason of the price and of the [steps].

Ukraine and Uzbekistan, 3G. On Uzbekistan, we are like owners of the 3G license, the WiMAX license, by the way, as well. We plan to start deployment of the network there in the end of this year, and it will take us another 2.5 years or three years to cover the main cities in Uzbekistan. We plan to go for commercial launch of the network, at least in Tashkent, in the first half of the next year, and we understand it's a very attractive business [case], though the paybacks are not extremely short.

And we hope it will also assist us in the developments on the -- as long as the penetration level would grow in Uzbekistan.

In Ukraine, we don't have a license. There is only one license issued by the regulator to Ukrtelecom. We received the signs from the regulator that we could potentially, the same as the other operators, apply for the UMTS licenses, but due to some recent changes in the, let's say, regulatory environment, this process unfortunately has been stopped. And now we have to, let's say, wait until the clearance of the situation will come, and then we'll knock on the door of the regulator once again to receive this license.

Your third question, Alex, I will pass over to Vsevolod.

Thank you, Leonid. Speaking about the amount of bonds maturing in January 2008, it's $400 million. And speaking about target capital structure, I would say that we do not have targeted capital structure as such.

Of course, we understand that we have room to increase our debt. However, at this stage, we are able to finance our strategy from the cash flow of the existing business. And in case there is an attractive opportunity to go outside of the existing businesses in the CIS or outside of CIS, we will be able to finance it from the increase of debt.

From the discussion of the credit rating agencies, the level of the debt to OIBDA, which of course will be discussed later on, specifically, with these agencies, but at this stage sort of leaves our credit agencies comfortable with is the 2.2 times debt to OIBDA.

Thank you.

Thank you very much. May I ask you for some clarification on the Uzbek license? You've mentioned that it's a WiMAX license. But do you have UMTS license as well?

Sorry, I was unclear. Of course we have 3G license, UMTS license, and we also have a license for the frequencies in 2.5 megahertz applicable for WiMAX.

Thank you very much.

And the next question comes from the line of Olga Bystrova. Please go ahead.

Hi. Full of questions, although some of them were already answered. Do you provide numbers of outgoing versus incoming calls in Russia and the Ukraine? Breakdown on usage, I mean.

No, I don't believe we disclose this.

Okay, great. Thank you very much.

And the next question comes from the line of [Vladislav Shulin].

Please go ahead.

Hi, just a follow-up question on your M&As. Are you currently holding any negotiations to acquire non-CIS assets, and, if yes, do any of the potential projects overlap with Sistema's own mobile telecom expansion plans, if any? Meaning them entering new markets directly by [or not by] MTS? Thank you.

I'm sorry. Do I understand your question correctly, that you ask us whether our M&A policy can come in conflict with Sistema's activities?

Yes. And also, if there are any current negotiations on you acquiring non-CIS assets, as well.

Well, I don't believe actually that that can happen, and I don't see the reason for that. Sistema has announced a number of times that they are very much committed in the development of MTS, and I've witnessed through my presence in the group, especially in MTS, no signs of potential conflict in such kinds of activities. So I don't think this is the case.

The other way around, we've, let's say, witnessed discussions when on the board of directors, first of all, where the Sistema has expressed its desire to support us in fulfillment of our strategy at full speed and is looking for opportunities to help us in the areas where they can.

Basically, you don't see any reason for them to even want to acquire mobile telecom assets, international assets, not by MTS?

As you know, in accordance to our PR and IR policy, we don't comment on the activities of our shareholders. That's why I would, if I may, recommend you to address this question to them directly.

Okay, and what about your current negotiations, if any?

With?

To acquire non-CIS companies, mobile companies.

Well, actually, even if we would be in such, we would hardly be prepared to comment, but I would say that our strategy is very much CIS-centric, and it was announced in the previous version, in 3+1 version, and we just confirmed it in our 3+2 version that we are, as MTS Group, we are very much devoted to our home market. This is CIS, and this is exactly where we have the, let's say, all possibilities, while our potential activities outside CIS is something of a secondary or third level of importance to us.

Thank you.

The last question, please?

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Okay, thank you very much, ladies and gentlemen, for your patience and for your interest to MTS. We welcome you at any time to contact our investor relations department for further questions. A webcast of this discussion will be available on our website if you wish to replay the call.

In the meantime, we appreciate your interest and wish you a very pleasant day. Goodbye.

And, ladies and gentlemen, that does conclude our conference for today. We thank you for your participation. You may now disconnect.